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QUESTION

May 23, 2016

Compute Net Present Value

Dungan Corporation is evaluating a proposal to purchase a new drill press to replace a less efficient machine presently in use. The cost of the new equipment at time 0, Including delivery and installation, is $200,000. If it is purchased. Dungan will incur costs of $5,000 to remove the present equipment and revamp its facilities. This 5, $30,000 per year. The existing equipment has a book and tax value of $100,000 and a remaining useful life of 10 years. However, the existing equipment can be sold for only $40,000 and is being depreciated for book and tax purposes using the straight-line method over its actual life.

Management has provided you with the following comparative manufacturing cost data:

The existing equipment is expected to have a salvage value equal to its removal costs at the end of 10 years. The new equipment is expected to have a salvage value of $600,000 at end of 10 years, which will be taxable, and no removal costs. No changes in working capital are required with the purchase of the new equipment. The sales force does not expect any changes in the volume of sales over the next 10 years. The company’s cost of capital is 15 percent, and it tax rate is 45 percent.

Required

Calculate the removal costs of the existing equipment net of tax effects.
Compute the depreciation tax shield.
Compute the forgone tax benefits of the old equipment.
Calculate the cash inflow net of taxes from the sale of the new equipment in year 10.
Calculate the tax benefit arising from the loss on the old equipment.
Compute the annual differential cash flows arising from the investment in year 1 through 10.